CRE Returns Split as Industrial and Data Centers Outperform

A Divided Market

Commercial real estate is becoming increasingly polarized. While some asset classes benefit from tight supply and surging demand, others, especially offices, are falling further behind, per Bisnow.

According to a new white paper from Davidson Kempner Capital Management (DKCM), the dispersion in returns across sectors and markets has reached levels not seen since the 1980s.

Sector Standouts

Industrial properties, self-storage, senior housing, and data centers are seeing strong rent growth and investor demand. DKCM notes that returns on industrial assets are up 12% over the past five years, while office returns have dropped 4%. Even within sectors, regional variation is sharp, industrial assets in California’s Inland Empire saw a 15% return increase, compared to 9% in Chicago.

Structural Reset

The market correction that began in 2022 with rising interest rates has triggered what DKCM calls a “structural reset.” Development has slowed due to elevated construction and borrowing costs, creating favorable conditions for existing assets in supply-constrained, high-demand locations.

Rate Pressure Builds

Higher borrowing costs and persistent inflation mean the “higher for longer” rate environment is likely here to stay. Combined with macro factors like labor shortages, reshoring trends, and global trade disruptions, DKCM says CRE performance will continue to fragment, benefiting resilient sectors and hurting laggards.

Capital Follows Strength

The growing clarity around sector winners is directing investor capital accordingly. Cap rate spreads are narrowing for top-performing properties, while underperforming assets struggle to find a floor. DKCM projects the divergence to not only persist but widen in coming years.

Tech-Led Growth

Data centers stand out as a future growth engine. Demand is six times higher than it was in 2021, thanks to AI, cloud infrastructure, and LLM development. DKCM predicts data center demand could triple again by 2030, with limited capital availability being the main constraint, not demand.

Next Moves

Investors nimble enough to acquire discounted assets in high-demand markets may achieve excess returns. Publicly traded REITs are already targeting sectors like senior housing and industrial, anticipating value recovery and future growth.

As DKCM’s Josh Morris puts it: “In a higher-interest-rate environment, complexity rises to the surface and creates more situations where you’re able to buy assets below as-is value.”